Investment Risks, Part 1

By: Marvin Germo | June 23, 2014

Each investment has a risk attached to it. Being that risks exists, it is not our job though to be scared of the risks but rather it is our responsibility to study and find ways on how can we manage the risk. Returning for our Tuesday column is fellow RFP, Rienzie Biolena to talk about Investment Risks.

We owe it to ourselves to invest—for our future, and our family’s future. Investing is one of the easiest way to beat inflation and guarantee that we can afford what we will need in the future.

But in the world of investing, it is not just Return that is the primary consideration. Equally important is the Risk involved as well. For the principle Rule of Thumb in Investing involves the two: “the higher the Return, the higher the Risk.” Think of it as two sides of the same coin, as knowing the risks of an investment can also be the key to preserving and maximizing your gains. Here are some of the risks that an investor faces:

Market Risk – the market is not always at the investor’s side. Sometimes it goes up, sometimes it goes down, sometimes sideways. But Market risk in general involves the movement of the market (whether stocks, bonds, forex, etc.) and the possibility that the price of your investment instrument will go down due this.

Country Risk – Think of a country rife with Civil War, run by a bankrupt and corrupt government, with a very high crime rate at that? Would you buy a stock of a Company there? Would you buy its government bond not knowing if it has the ability to pay? That is Country risk. Generally, investors want a country that is peaceful, with a strong development that, ultimately, paves the way for good businesses and good stock picks. In fact, countries are assigned risk premiums—additional rates of return required by them to consider investing in these countries.

Interest Rate Risk – This is mainly affects bond holders: a falling interest rate environment is generally more desirable for them because the value of the bonds that they are holding would be worth more. For instance, if you have a bond giving 10% return, a falling interest rate environment would mean future issuances can be at 9%, 8% or even 4% coupon rates. As such, other people would want and a lot would pay more just to have that instrument giving 10%. The reverse is true: a rising interest rate environment is not good for bondholders as nobody would buy a 4% bond if in the future, there would be issues that give higher rates of return. As such, the lower rate bond might be sold at a loss or lose its value when sold in the market.

Reinvestment Risk – If you buy a bond, chances are is that the present rate of return is way different from what you have before: you may now be reinvesting your coupon payment or principal at a lower coupon rate. This risk—the risk that the money you receive from a bond would be reinvested at a lower rate.

On the next article, I shall be tacking on more risks that an investor should be conscious of, all to maximize on his returns.

———————————————————————————————————————————————-

Rienzie P. Biolena is one of the pioneering Registered Financial Planners of RFP Philippines. He is also an Accredited Investment Fiduciary of Pennsylvania-based fi360, a Certified Financial Consultant from Institute of Financial Consultant-Canada, and a Chartered Wealth Manager of the American Association of Financial Management.